Funeng Oriental Equipment Technology Co., Ltd. (SZSE:300173) shares have continued their recent momentum with a 67% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 66%.

After such a large jump in price, you could be forgiven for thinking Funeng Oriental Equipment Technology is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 6.3x, considering almost half the companies in China's Machinery industry have P/S ratios below 3.3x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

What Does Funeng Oriental Equipment Technology's P/S Mean For Shareholders?

For example, consider that Funeng Oriental Equipment Technology's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Funeng Oriental Equipment Technology?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Funeng Oriental Equipment Technology's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 21% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 18% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 23% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Funeng Oriental Equipment Technology's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Final Word

Shares in Funeng Oriental Equipment Technology have seen a strong upwards swing lately, which has really helped boost its P/S figure. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Funeng Oriental Equipment Technology currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Funeng Oriental Equipment Technology (at least 2 which are potentially serious), and understanding them should be part of your investment process.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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